By locking in dollar revenues at an average of $1.60 per
pound for that long, Rolls-Royce won’t enjoy short-term benefits
from the 8.8 percent plunge in sterling to a 2 1/2-year low of
$1.4832 on March 12 from $1.6255 on Dec. 31, a move that would
typically boost U.K. exporters.

“In the short term, companies with less long-term hedging
coverage will outperform Rolls Royce,” said Ben Fidler, an
aerospace and defense analyst at Deutsche Bank in London. “The
earnings of Rolls-Royce will gain 15 percent in the long-term
only if sterling stays at its new, weaker level.”

Rolls-Royce, which derived 32 percent of its 2012 revenues
from U.S. customers, provided details of the currency trades in
its annual report this month. About half of these hedges will
expire between 2014 and 2018, the report said.

“Rolls-Royce operates in a number of very long cycle
businesses and we therefore have a long-term hedging program to
provide a degree of certainty to our cash flows going forward,”
Rolls-Royce spokeswoman Jane Terry said in an e-mailed
statement.

Hedging Program

“Our hedging policy is structured so that Rolls-Royce can
take advantage of short-term movements in market rates, albeit
that the existence of the hedging program means that we have
swapped some flexibility for the certainty that it provides,”
she said.

Rolls-Royce reported 750 million pounds ($1.14 billion) in
unrealized profit on derivatives in 2012, when the dollar
weakened to $1.6255 from $1.5469 at the beginning of the year.

The company may have lost as much as 1.2 billion pounds on
those derivatives this year, according to a Bloomberg analysis
of the forward currency derivative contracts disclosed in its
annual report.

The pound has weakened 5.4 percent this year, the second-
worst performer after the yen among 10 developed-market
currencies tracked by Bloomberg Correlation-Weighted Indexes,
amid speculation the Bank of England will expand its asset-
purchase program to spur the economy, a policy that usually
debases a currency. The euro rose 1.4 percent and the dollar
gained 3.3 percent.

King’s Comments

The pound rose today after Bank of England Governor Mervyn King said yesterday policy makers aren’t trying to talk down the
currency, while acknowledging that its drop since before the
financial crisis has helped exports.

“The markets determine the level of exchange rate, not
us,” King said in an interview with ITV News, according to a
transcript of his remarks. “We’re certainly not looking to push
sterling down.”

The profit-and-loss swings on currency derivatives are a
consequence of Rolls-Royce’s decision not to use hedge
accounting, Terry said.

“This does result in volatility to our headline P&L
numbers, which we remove for underlying purposes,” she said.

Hedge accounting is where the impact of gains and losses
due to currency swings on forecast revenues is combined with
offsetting gains and losses on the derivatives purchased to
hedge them, so that the effect of currency swings on headline
earnings is reduced.

Record High

Rolls-Royce shares climbed to as much as 1102 pence today
in London, the highest on record, according to data compiled by
Bloomberg starting in 1988.

Meggitt Plc (MGGT), a U.K. aerospace components group that’s the
largest provider of wheels and brakes for military aircraft, is
an example of a company less affected by long-term hedges and as
a result is better positioned for a weak pound, Deutsche Bank’s
Fidler said.

Meggitt’s Chief Executive Officer Stephen Young said the
company will benefit from currency effects this year.

The exchange rate will probably be “a tailwind, not a
headwind,” Young told analysts on March 5.

A spokesman for Meggitt didn’t return e-mails seeking
comment.

GKN Plc (GKN), a supplier of parts to Boeing Co. (BA) and Airbus SAS
jetliners, also highlighted the benefits of a weaker pound
because it will boost earnings when foreign-currency payments
are translated into sterling.

“Right now currency is a tailwind,” GKN’s Chief Executive
Officer Nigel Stein said on a Feb. 26 earnings call. “If we get
a tailwind, we’ll say thank you very much for that.”